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32 Figure 6.8 An incremental approach. Stops are incrementally lowered to levels 2, 3, 4, and 5. we decide to sell on the close when the uptrend line is broken. Initial stops are placed at the previous days high, every time the market closes 10 points from our entry price, we lower stops 5 points until we are stopped out. position was exited as price crossed back over level 5. S&P 500 08/02/96  (1) Initial stop (2) (3) (1)- STops lrjoeretf uith closes ..(5). position.exited...stopped.dux 685 680 675 670 665 660 655 650 645 640 635 630 625 620 615 610 96 10 22 29 ft when short and the previous days lows when long. Hold until you get stopped out. Make sure initially that the previous days high/low is not to far away. We do not want to incur any more risk than is necessary. Another variation is to add/subtract an increment to the high/low that you use to reduce the chance that a false move would stop you out of your position. Perhaps in a long position you can use the previous days low minus 0.1 ticks. Look at the market you are trading and determine what levels work best. Perhaps a two-day low works better than the previous days low. You may decide that the low of the last three bars is better. Experimentation is recommended. Longer-term traders can use weekly or monthly highs/lows for their stops. In Figure 6.10, experiment to find the best number of ticks to add to the high/low. On June 10, we go long. On June 11, the market takes out the previous two days of lows by several ticks and then continues to rally. We could have avoided getting stopped out by adjusting it downward by a predetermined amount.
Figure 6.9 placing stops at the trailing days highs and lows, exit long and sell when price crosses below the stop. exit short and buy when price crosses over stop. | | | | SIM) | | 05/16/96 J | | | | | | | | | 12.0 11.9 11.8 11.7 11.6 11.5 11.i 11.3 11.2 11.1 11.0 10.9 10.8 10.7 10.6 10.5 10.4 10.3 10.2 10.1 10.0 | | bit \ | trailing hijhs } J { Buy \ I f trailing lous | 12.0 11.9 11.8 11.7 11.6 11.5 11.4 11.3 11.2 11.1 11.0 10.9 10.8 10.7 10.6 10.5 10.4 10.3 10.2 10.1 10.0 | | | | 96 15 | 22 29 11 | | | |
indicators Indicators are used mainly for analyzing the markets, but you can also use them for a stop approach as well as an exit strategy. We will look at several of the more popular indicators and how you can include them in with your current approach for stop techniques. Stochastic Stochastic is a popular overbought/oversold indicator developed by George Lane. In general, whenever the indicator goes above 70-80, the market is considered to be overbought (look for a sell-off). When the indicator drops below 30-20, the market is considered to be oversold (look for a rally). As a stop technique, we can look at the value of the indicator rather than the levels used for its original analysis. Once you enter a position, look at the value of a stochastic. Place your initial stop and look to exit a long position when the indicator falls for one day or for two
Figure 6.10 Stops incrementally lowered to levels 2, 3, 4, and 5. position was exited as price crossed back over level 5. by trailing the lows with .10 ticks, you could have avoided being stopped out prematurely. Deutsche m inn 07/01/36 H louer \ stop hit stop is-* not hit 66.6 66.5 66.4 66.3 66.2 66.1 66.0 65.3 65.8 65.7 65.6 65.5 65.4 65.3 65.2 65.1 65.0 64.3 64.8 64.7 64.6 consecutive days. This will enable you to avoid getting stopped out by random moves in the market. Such moves usually do little to change the value of a technical indicator. The Relative Strength Index (RSI) is another popular indicator that you can use. Figure 6.11 shows a 10-period stochastic indicator and an exit when the stochastic was high and turned down. Momentum Momentum and least squares momentum are two of my favorite indicators. A five-bar momentum of the closing price is simply the difference between todays closing price and that of five bars ago. Least squares momentum (LSM) is a method used to smooth out the momentum indicator and alleviate some of the "noise" that indicators can have. This technique is a bit more involved than the other techniques discussed so far. To make a five-bar LSM of the closing price, first fit a straight (regression) line through the most recent five closing price points. The LSM is the slope of this regression line. Make sure that you are comfortable with an indicators
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